A Disconnected Middle East

New research by the McKinsey Global Institute shows that the Middle East/North Africa region is falling behind in global flows of goods, services, people, finance and data. To reverse the trend, follow the example of Morocco and Dubai.

The world is becoming ever more connected as global flows of goods, services, people, finance and data bind countries, cities, companies and individuals more tightly together.1 Today the web of cross-border exchanges has exploded in scope and complexity.

Two major forces are now accelerating the growth and evolution of global flows. The first is increasing global prosperity. By 2025, 1.8 billion people around the world will enter the consumer class, nearly all from emerging markets. Emerging market consumers will spend $30 trillion annually, up from $12 trillion today.2 This is already creating enormous new hubs of consumer demand and global production. The second major force is the growing pervasiveness of Internet connectivity and the spread of digital technologies.3 More than two-thirds of the world’s citizens have mobile phones and, as of 2012, 2.5 billion of them were connected to the Internet. As a result, a torrent of data now travels around the world.

Most countries in the Middle East and North Africa (known as the MENA region) are missing out on the full breadth of growth opportunities that a more deeply interconnected world presents. New research from the McKinsey Global Institute (MGI) estimates that global flows contribute between $250 billion and $450 billion to global GDP growth each year—equivalent to 15-25 percent of total growth.4 We find that greater connectedness helps drive faster economic growth—and the most active participants in global flows can reap enormous benefits. Those countries that are most centrally connected within flow networks can gain up to 40 percent more GDP growth from flows than the least connected countries.

The MENA region as a whole has seen its connectedness across all five types of flows actually decline over the past fifteen years. It remains too reliant on cross-border exchanges of commodities in an era when higher-value, knowledge-intensive flows are gaining in importance. While other regions are deepening their trading ties and developing sophisticated cross-border supply chains, the MENA region is only weakly connected in terms of intra-regional trade. Although MENA’s flow intensity—or the level of its financial, goods and services trade relative to its GDP—has increased faster than the global average since 2002, the region remains in the middle of the pack on this measure, and far behind Southeast Asia and China’s lead. The question now is: How can MENA policymakers reverse these trends and build the connections needed to prosper in a more globalized world?

Our Connected World Although globalization appeared to stall during the 2008 financial crisis and its aftermath, world trade in goods and services as well as global capital flows are now growing once more. By 2012, these three types of flows reached $26 trillion, or 36 percent of global GDP—more than 50 percent larger relative to the size of the world economy than they were just twenty years ago. But the MENA region has not shared in this rebound. Its flows of goods, services and finance stood at 109 percent of the region’s GDP in 2007, but are only 71 percent of GDP today. This drop reflects a sharp decline in flows of goods and capital—the former was 20 percent lower relative to GDP and the latter was 8 percent lower.

Nor has MENA shared fully in the broader global trend of more countries participating in flows. While MENA increased its share of all major flows between 2002 and 2012, it did so more slowly than other emerging regions on average in the categories of goods, services and finance. At a global level, the concentration of goods exports among the top three countries declined between 1995 and 2012, but in MENA, the share attributable to the top exporters increased dramatically from 55 to 67 percent.

Our new report, Global Flows in a Digital Age: How Trade, Finance, People, and Data Connect the World Economy, features an index of “connectedness” that measures cross-border flows of goods, services, finance, people, and data and communications.5 In addition to allowing country-by-country comparisons, it includes regional rankings (calculated by averaging country rankings, weighted by population). The MENA average ranks 47th in the world, making it the second-worst-performing region; only Sub-Saharan Africa is less connected. More worrisome is that its level of connectedness declined three places from 1995 to 2012, even as South Asia made a gain of ten places and Latin America and the China region each climbed five places. While other parts of the world have built more robust and diverse global networks, MENA countries have by and large allowed these opportunities to slip through their fingers.

At an individual country level, some MENA countries were among the world’s biggest decliners in the index. From 1995 to 2012, the rankings for Yemen, Tunisia, Syria and Egypt slid by twenty-two, nineteen, sixteen, and twelve positions, respectively, reflecting their economic and political turmoil.

However, some countries in the region have defied this trend and deepened their connections to the rest of the world. Morocco gained twenty-six places between 1995 and 2012, and now ranks 53rd in the world. This is the second-largest gain of all 106 countries in the MGI index, reflecting the government’s aggressive efforts to open the economy to flows of goods and services and forge a new role as an offshore manufacturing and service hub for the large European market. Saudi Arabia gained nineteen places over this same period. This is largely due to surging financial flows as the kingdom capitalized on rising energy prices since 2000 to invest oil revenues overseas; it also reflects large inflows of foreign labor. Saudi Arabia now ranks 16th in our global connectedness index, the highest of any country in MENA. More broadly, the GCC countries as a group have the strongest participation in global flows in goods, finance, and people, and they are laying the infrastructure to participate more fully in knowledge-intensive flows.

There are other positive examples within the region. Israel gained nineteen places since 1995 due to its strength in people flows and services as well as its growing specialization in knowledge-intensive exports. The country accounted for 11 percent of MENA’s exports of R&D-intensive goods and 45 percent of its exports of knowledge-intensive services in 2012. Oman made even more striking gains in the index, climbing twenty-five places. And while the United Arab Emirates is not ranked due to a lack of data reporting, there can be little doubt that Dubai has emerged as a major global waypoint in air travel, shipping and finance. The city’s airport has been increasing total passenger capacity at a rate of 12 percent per annum over the past decade and is now one of the world’s top ten hubs for international air travel. Dubai has also become a major player in global shipping flows. In 1980, it didn’t rank among the world’s top twenty-five container ports; by 2011, it was in the top ten. More recently, Abu Dhabi has invested significantly in Internet connectivity, which could position them well going forward in data flows.

Commodities, Finance and People The global goods trade (which includes commodities) is by far the largest type of flow, accounting for $17.8 trillion in 2012, more than four times the value of traded services or financial flows.

MENA has historically enjoyed a trade surplus and this has doubled relative to regional GDP over the past decade, from 3 percent to 6 percent. This surplus is mainly due to its substantial commodity surplus (15 percent of GDP), which helps finance deficits in other categories. In 2012, MENA recorded a deficit in services and all other major categories of goods trade.

MENA’s total trade in both commodities and goods grew in line with the global average over the past decade (rising 16 to 17 percent annually). But looking more closely at the components of this flow, MENA is more than twice as reliant on commodities trade as other regions, reflecting its natural resource endowments such as petroleum. Some 55 percent of the region’s goods trade is in commodities, compared with a world average of 28 percent. MENA accounted for 31 percent of all oil and gas exports in 2012, nearly half of the emerging world’s share of global exports.

Although cross-border financial flows remain substantially below their peak before the 2008 crisis when measured as a share of global GDP, the global network of financial flows has nevertheless become more interconnected over the past ten years. Growth of nominal financial flows has been 5 percent a year since 2002 across all countries, and 20 percent for emerging markets. The MENA region has outstripped both of these benchmarks, with financial flows rising 22 percent per year on average. In 2012, its financial flows stood at 13 percent relative to GDP, above the emerging market average of 10.6 percent. Financial outflows grew from 2.5 percent of GDP in 2002 to 11 percent in 2012, reflecting the recycling of oil wealth into global financial markets.

Foreign Direct Investment (FDI), both in and out of MENA countries, is also growing quickly. These flows have grown 22 percent per year since 2002, twice as fast as the world average. The region’s inflows of FDI were 15 percent higher than its outflows—but they were concentrated in just a handful of recipient countries. The UAE, Israel, Iraq, Morocco and Egypt together attracted almost 80 percent of MENA’s total FDI inflows in 2012.

The Middle East also plays a prominent role in global flows of people. The region is home to around 6 percent of the world’s population but its share of world migrants is nearly 12 percent. Moreover, the region’s share of global migration is growing twice as fast as the global average, at 4 percent per annum between 2000 and 2010 (compared with the global average of 2 percent growth). MENA’s share of global travelers and students enrolling in foreign universities is also rising faster than the global average.

Data and Knowledge Global flows are not simply growing in volume; their very nature is changing. Commodities and labor-intensive goods from low-cost manufacturing nations once dominated global flows, but today all types of flows are becoming more knowledge-intensive. Exchanges of high-tech products, pharmaceuticals, automobiles, sophisticated business services and FDI—all of which require a high level of R&D or utilize highly skilled labor—take on heightened importance to economic growth as they transmit ideas, innovation, new technology and expertise.

In 2012, global knowledge-intensive flows reached $12.6 trillion, nearly half the combined total value of goods, services and financial flows. And they are gaining share: their growth rate is at least 1.3 times faster than growth in labor-intensive flows. But MENA’s participation is lagging, raising the concern that the region is not positioned to share in this growth potential. Knowledge-intensive goods accounted for 30 percent of its total goods trade in 2012, well below the emerging market average (43 percent) and the global average (50 percent). Looking more closely at exports only heightens this concern. Only 15 percent of MENA’s total goods exports are knowledge-intensive, less than half the average across all emerging markets (37 percent) and less than a third of the global average (50 percent). Given that Saudi Arabia and Israel together accounted for nearly one-quarter of the region’s total exports of knowledge-intensive goods exports in 2012, it is clear that most MENA countries have fallen far behind.

Underlying growth in all types of global flows—and especially the rise in knowledge-intensive flows—is an explosion in the world’s exchange of data and communication. Cross-border Internet traffic increased eighteen-fold between 2005 and 2013. The economic implications of this growth could be profound, as data flows not only facilitate other major types of flows but enable catch-up growth through the sharing of information and the lessening of infrastructure requirements. However, MENA, like other emerging market regions, is not highly connected to data flows and so is likely missing out significantly on this potential. In 2012, MENA represented 6 percent of the world’s population but only 2 percent of global cross-border traffic. On a per capita basis, its residents account for less than 1/24th of the Internet traffic generated by Western Europeans due to a lack of low-cost, high-quality access. Saudi Arabia is the only country in the region ranked in the top 50 on connectedness to data and communication flows in 2012—and it is in 44th place.

But the network of global data and communication flows is developing and dispersing more rapidly than any other type of flow, and it is making inroads in the region. MENA’s cross-border Internet traffic grew at 68 percent per annum from 2005 to 2012, the second-fastest growth rate among emerging regions. However, the region’s digital divide with the rest of the world remains considerable. Increasing participation in data and communication flows will be vital if MENA countries are to maximize their potential in the global knowledge economy.

Open Borders MENA has successfully diversified its trading partners, with the balance shifting toward the emerging world. In 1980, developed regions accounted for 70 percent of the region’s total goods trade. In 2011, however, their share declined to 47 percent while Asia grew to nearly 40 percent. MENA has become less reliant on trade with the United States, Canada and Western Europe; their combined share of imports and exports of goods from the region both fell by roughly half. During the same period, other parts of the world became much more significant partners for MENA, as rising incomes drove consumption and commodity demand. Northeast and Southeast Asia have become MENA’s two largest export markets, with a combined share of 42 percent of total exports. China, once a relatively insignificant partner, now accounts for 10 to 11 percent of MENA’s goods trade.

But MENA countries are missing out on opportunities to trade more intensively with one another. MENA’s intra-regional share of total trade in goods has been flat at 6 percent over the past decade. Trading blocs such as ASEAN (22 percent), NAFTA (39 percent) and the EU (59 percent) achieve far higher levels of intra-regional trade. Eastern Europe and Central Asia (33 percent), Southeast Asia (24 percent), the China region (17 percent) and Latin America (19 percent) all post three to five times as much trade between regional partners as MENA. Diversifying the region’s production of manufactured goods as well as its tradable services would unlock opportunities for future growth.

Challenges of the Global Marketplace The MENA region faces a significant challenge in raising its participation in global flows and its overall connectedness. But it starts with an inherent advantage: its very position on the globe.

MENA’s geographic location puts it at the center of physical flow networks between Europe, Asia and Africa. Nearly 6 billion people live within an eight-hour flight from Gulf countries. This provides a significant opportunity to act as an intermediary in global flows—an opportunity that Dubai has already begun to seize with its new role as a hub for air travel. Other MENA countries could emulate the success of the UAE in exploiting its natural geography to participate as waypoints of flows.

MENA can also capitalize on its proximity to major markets. Morocco’s climb of twenty-six places in our connectedness ranking has been largely due to its role as a manufacturing base for Europe—and its regional peers can similarly position themselves to serve large markets in other categories.

To prepare for the next wave of growth, MENA countries can look to the examples offered by Morocco and Israel, which account for large shares of the region’s cross-border Internet traffic and its knowledge-intensive exports. Both countries have actively invested in developing niches within global value chains and building the specialized human capital required.

As barriers come down, the world is increasingly transforming itself from a set of discrete, isolated markets into a true global marketplace—one in which goods, services, capital, people, and data and communication move ever more seamlessly across borders. Integrating into these global networks presents greater opportunity, and the failure to do so now imposes a greater cost on those countries that are left behind. From Morocco to Dubai, the Middle East already boasts some trailblazers that have embraced this new era and are thriving as a result. Will others now follow?

James Manyika is a senior partner at McKinsey & Company and a director of the McKinsey Global Institute, the business and economics research arm of the international consulting firm. Previously he served on the engineering faculty at Oxford University. He serves on President Obama’s Global Development Council and on the Innovation Advisory Board at the U.S. Department of Commerce. He has contributed to the Financial Times, Economist, Newsweek, Les Echos, Washington Post, Forbes, and McKinsey Quarterly.

Susan Lund is a Washington-based partner at the McKinsey Global Institute, the business and economics research arm of McKinsey & Company. She leads the group’s research on global financial markets, labor markets, and the macroeconomic outlook. She has contributed to the Harvard Business Review, Washington Post, and McKinsey Quarterly, among other publications. On Twitter:@SusanLund_DC.

We define goods and service flows as the sum of imports and exports of goods and services for each country. Financial flows are the inflows and outflows of foreign direct investment, equity and bond flows, and cross-border lending and deposits. People flows include the number of people who move for long-term migration, short-term travelers and students. Data and communication flows include the volume of cross-border Internet traffic and international call minutes. For each flow, we also explore emerging digital flows such as e-commerce, online work platforms, remittances and payments, and other micro-data.